Arbitrage is a popular trading strategy that involves buying an asset in one market and selling it in another to take advantage of price differences. In its simplest form, arbitrage involves buying a stock on one exchange and selling it on another, making a profit from the price difference between the two markets. For example, a car manufacturer’s stock may cost $45 on the NYSE, but it is being traded at $45.30 on the SSE. A trader buys these stocks on the NYSE and sells them on the SSE, making a profit of 30 cents per share. This is a basic example of arbitrage trading.
Arbitrage trading with cryptocurrencies works similarly to traditional arbitrage trading on the stock market. Just like arbitrage traders aim to make profits through cross-market buying and selling, crypto arbitrage traders try to profit from the different listing prices on various exchanges. For example, an investor buys 100 Solana coins on the cryptocurrency exchange Coinbase for $14 per coin and sells them on the eToro exchange for $14.10, making a profit of 10 cents per share by trading them on a different platform.
There are different types of crypto arbitrage trading. The most common types include spatial arbitrage, spatial arbitrage without transfer, and triangular arbitrage.
Spatial arbitrage, also known as geographical arbitrage, is when an investor simply buys cryptocurrencies on one exchange, sells them on another, and cashes in the profit. Investors can trade crypto between centralized exchanges (CEXs) or decentralized exchanges (DEXs) and exploit the technical inefficiencies of an exchange, such as price delays and listing differences, to make profits.
Spatial arbitrage without transfer is the most common and simplest form of arbitrage trading. An investor takes a long position in a cryptocurrency on one exchange and a short position in the same cryptocurrency on another exchange. This means that investors hedge against significant losses and can earn small profits from price fluctuations at different exchanges.
Triangular arbitrage involves three types of currencies involved in a triangular transaction – the two coins and the fiat currency used. Triangular arbitrage works as follows: the investor signs up for their crypto exchange or trading account and buys Bitcoin on their account using their fiat currency, such as pounds sterling or US dollars. The investor transfers this Bitcoin to another exchange or wallet and buys 10 Ethereum with this Bitcoin. The investor then sells their current stock of Ethereum – at a higher price than the initial Bitcoin cost – and buys back the original Bitcoin at the starting price to complete the triangle. While profitable when executed correctly, these opportunities are rare and not a method commonly used by traders.
To find crypto arbitrage opportunities, investors need to be able to recognize them. To identify a lucrative crypto arbitrage opportunity, investors need to:
- Browse the market for price changes: Whether manually or using a tracking tool to do the heavy lifting, comparing cryptocurrency prices across different platforms is crucial to know where to buy and sell.
- Use trading pairs: Trading pairs help determine the comparative value of two cryptocurrencies or between a coin and a fiat currency. For example, an exchange may show that a Bitcoin token has a value of X Ethereum on its interface, and vice versa. With this value, it becomes easier to calculate how much a coin is worth when trading, making it easier to recognize whether the exchange rate is favorable to you.
- Stay updated on exchange rates: Another crucial aspect of crypto arbitrage is keeping track of fiat currency exchange rates. For investors buying and selling cryptocurrencies across global CEXs and DEXs, understanding the developments in fiat currencies can impact how much profit they make when selling all assets.
Arbitrating cryptocurrencies comes with several potential advantages. Some of the main benefits of cryptocurrency arbitrage trading include:
- Low risk: As crypto arbitrage trading often involves simultaneous buying and selling or trading on different markets, traders hedge their losses through a counter-investment, minimizing the risk for the trade.
- Potential for quick returns: Arbitrage trading has a fast turnaround – once investors spot an opportunity, they seize it. The nature of quick arbitrage trading and currency conversions at a desirable rate means that profits can be realized within minutes.
- Industry volatility: Volatility is not typically associated with positive financial investments, but it is an essential part of arbitrage trading. Cryptocurrencies are inherently volatile as the supply and demand for a coin is largely based on speculation. The markets are constantly moving, revealing daily price discrepancies and inefficiencies across many crypto exchanges. It is these inefficiencies that open the door to profits for traders.
- Works in bull and bear markets: Regardless of whether the market is rising or falling, the number of arbitrage opportunities remains the same. While bull markets are more desirable, traders can hold both long and short positions and make money regardless of whether the markets are bullish or bearish.
However, like any investment strategy, cryptocurrency arbitrage comes with certain risks. Some of the disadvantages of crypto arbitrage include:
- Withdrawal limits: Some cryptocurrencies limit the amount you can withdraw at a given time. Investors need to understand these limits and choose exchanges that offer the most favorable withdrawal fees to maximize profit in short-term trades.
- Transaction fees: All trading platforms and cryptocurrency exchanges charge fees for buying, selling, and withdrawing money or coins from a wallet. Investors need to consider these fees before engaging in arbitrage trades. The fees for buying, selling, and withdrawing coins or fiat currencies can outweigh the profit from executing a successful arbitrage trade, adding additional complexity levels for both novice and experienced investors.
- Slow transaction times: As competition for a share of the crypto pie increases, transaction times also increase due to the increased volume. As funds need to be swiftly reallocated and withdrawn, these long waiting times can make a difference in whether an investor benefits, misses an opportunity, or loses out entirely.
- Precise timing required: The entire trade is relatively time sensitive, but none more so than arbitrage trading. When prices don’t match between exchanges, and an opportunity arises, investors have minutes or even seconds to react and make a profit. Traders need to be quick to reduce the risk of the market turning against them, which is why this method is best suited for more experienced traders.
Which coin is best for arbitrage?
Arbitrage can be conducted with any cryptocurrency coin or token